How rich a 'chocolate' for the economy

October 16, 1981

By David R. Francis

Boston

This is a column about Ms -- not M &amp; Ms candy or "m-m-m good" soup -- but the various measures of money. Though undoubtedly less flavorful for most people than good food, the Ms have Washington and the financial community as excited as a hungry youth about to dig into a Thanksgiving Day turkey.

The key problem is that "M1-B shift adjusted" -- one measure of money that includes cash and checkable deposits -- has been expanding at a rate slower than the 1981 target set by the Federal Reserve Board. But M-2, a broader measure of money which includes savings accounts, money market funds, and so on, has been running at the top of its target range.

Money is important as the lubricant that keeps the economy turning over. Too much money and it spins too fast, resulting in inflation. Too little and it slows into a recession.

The Reagan administration and the Federal Reserve System, which controls the creation of new money, are agreed nowadays that in recent years too much money was turned out. Both want to ease back on the supply to tame inflation.

There is a debate now between Fed and administration officials as to the degree of monetary tightness that's needed -- and it has something of the flavor of two people arguing over which kind of chocolate is best.

The White House doesn't want to risk too much of an economic slowdown for far of its damaging Republican prospects in congressional elections next year. So Treasury Secretary Donald Regan has been publicly urging the Fed to boost M-1B into its target range. Chairman Paul A. Volcker has been defending the Fed stand.

But it may be a debate in the dark.

For one thing, the Fed has already been striving to expand the money supply. Since July it has been providing banks with what is called "nonborrowed reserves" at close to a 20 percent annual rate. Some of those reserves will eventually be used by the banks to make loans, which in turn become money (that is, bank deposits). That is a significant effort to push the economy along. But apparently not enough to satisfy Mr. Regan.

Another problem is that the statistics of money are crude. A former director of research and statistics for the Fed, Guy E. Noyes, says that ". . . we simply have to recognize that the numbers we get either weekly or monthly are a very imperfect measure of whatever M we are trying to estimate and control."

In an arcile in the October issue of the Morgan Guaranty Survey, a bank letter, and in a telephone conversation from his retirement home in Florida, Mr. Noyes pointed out that major differences prevail between original estimates of the Ms and the subsequent revisions and re-revisions. For instance, the rise in the narrowly defined money in the first 10 months of 1970 was first reported at 3.9 percent. It was later revised to 5.6 percent. And such revisions continue.

So it is possible that future revisions of M-1B could put it within today's target -- or further below target. No one knows for sure.

Moreover, many adjustments have to be made in the M figures to account for changes in the financial system. How do you calculate money when money market funds are growing in size by perhaps $2 billion a week? Or what happens when the introduction of an All Savers certificate produces a shift in the size of the various Ms? How do you seasonally adjust such statistical changes?

Some monetarists, probably including Beryl Sprinkel, the Treasury undersecretary for monetary affairs, argue that because of such uncertainty in the numbers, it is best for the Fed to stick firmly to its target -- M-1B shift adjusted in this case. Though the results of such a rigid policy would not eliminate cycles, they would produce smaller variations in business activity, they maintain.

Other economists, such as Noyes, maintain that the Fed should not "mindlessly" embrace one measure or another measure of money. "You have to look at everything to make a decision as to whether you are providing an excess of cash balances or being too parsimonious," the former Fed economist said.

In a sense, this difference results from varying degrees of faith. Noyes has faith that the Federal Open Market Committee -- the Fed body that sets the nation's monetary policy -- has sufficient knowledge and wisdon to vary the creation of money to benefit the economy. Strict monetarists lack that trust.

As a buttress for his faith, he cites a study by economist Anatol Balbach recently publishe din the Monthly Review of the St. Louis Federal Reserve Bank, a monetarist stronghold in the Fed system. The study finds that most of the much criticized wide fluctuations in the rate of M-1B growth in 1980 was due by far to variation in the so-called "multiplier," which is the relationship between the monetary base and M-1B. The monetary base includes bank reserves, and the Fed controls it directly. But the Fed does not control in the short run how much of these reserves are used to make loans and create money. If the Fed had taken account of the changing multiplier as it was observed, it could have done a better job in controlling M-1B, Noyes says.

This is a technical argument, but in these days of monetarist dominance in Washington and Wall Street it's causing excitement among the experts. Probably most of the public finds it dull and unintelligble. Perhaps it's enough to know that the debate is basically over whether the economy should be slowed a bit -- or a bit more -- in 1982.